Is Apple a Rotten Investment?

Everybody knows about Apple (NASDAQ:AAPL) and its products. However, the question on investors’ minds is what the future holds for the company’s stock price. Apple is currently trading at around $400, far below its highs of more than $700 in September. With that said, is Apple an OUTPERFORM, WAIT AND SEE, or STAY AWAY?

C = Catalysts for the Stock’s Movement

Apple’s strength has always been innovation: creating new products that change the way we work and play. But Apple has failed to introduce a new product since November, and investors believe the company is losing its edge in innovation to competitors. CEO Tim Cook hoped to change this sentiment at Apple’s Worldwide Developers Conference several weeks ago. He referred to Apple’s new product offerings as “game changers,” but the conference only left investors wanting more. The only two products Cook unveiled were iOS 7, an update to existing iPhone and iPad operating systems, and iRadio, a music streaming service that hardly seems different from Pandora (NYSE:P) or Google’s (NASDAQ:GOOG) Play Music All Access service. While these new products may enhance the synergistic effects of the Apple ecosystem, neither will provide a big boost to Apple’s bottom line in the near future.

The average selling price of Apple products has recently been in steady decline. A lower average selling price, especially for the iPhone and iPad, will most likely lead to a lackluster third-quarter earnings announcement. The company’s quarter-over-quarter gross profit margin fell 10 percentage points in the second quarter. These declining margins are the result of consumers favoring the cheaper iPhone 4S over the iPhone 5 and the increasing popularity of the lower-margin iPad mini relative to the regular iPad. Increasing competition in the smartphone and tablet space from competitors like Samsung and Google have also reduced Apple’s high profit margins.

Apple’s share price is likely to remain neutral or even trend downward as we move toward its third-quarter earnings announcement, likely to come in late July. For the past two years, analysts have periodically cut Apple’s quarterly estimates several weeks before the earnings announcement; these estimate reductions certainly don’t help the share price, and reveal little about the actual performance of the company. Analysts that are highly optimistic on Apple will be few and far between until the company unveils a truly innovative new product.

H = High-Quality Products in the Pipeline?

As one of the most secretive companies on the planet, it is difficult to know for certain what types of features we can expect from Apple in new product offerings. At the All Things Digital conference last month, Cook hinted at entering the wearable technology market, saying it’s an “area ripe for exploration.” It is difficult to estimate the success the iWatch or a similar product would have in the marketplace since, so few details are known, but a truly novel product offering is vital to restoring positive investor sentiment.

Another upcoming product release is a lower-priced iPhone, projected to cost $399 without a carrier subsidy. A lower-priced phone is an important weapon for Apple as it battles with another smartphone heavyweight, Samsung, for customers in emerging markets. Apple has lost sales to Samsung recently, but the introduction of a cheaper phone should be successful, especially as smartphones continue to gain popularity in emerging markets. Apple is in talks with China Mobile, China’s largest carrier, to reach a distribution deal that could allow Apple access to 700 million consumers in the Chinese smartphone market.

Let’s now use some fundamental analysis to help determine whether Apple is an OUTPERFORM, WAIT AND SEE or STAY AWAY.

E = Exceptional Performance Relative to Peers?

Despite recent sentiment that the company has lost its luster, fundamentals are solid for Apple right now. Apple is sitting on a huge pile of cash that it plans to use to increase stock dividends and help fund a $50-billion share repurchase program. Both financial policy decisions will increase the desirability of the stock. Moreover, because of recent pullback in Apple’s share price, new investors will enjoy higher yields from the new dividend and the stock buyback. Apple’s dividend is currently yielding an attractive 3 percent, more than that of its competitors Microsoft (NASDAQ:MSFT) and Google.

Apple is cheap to own right now compared to its historical price-to-earnings ratio. It also is cheap to own relative to two other industry giants: Google and Microsoft. Generally, stocks with higher P/E ratios are more expensive because they have higher growth prospects; but if you believe that Apple will regain its innovative edge in the marketplace, it could be a good time to buy. Also, Apple trades at a much lower price to free cash flow multiple relative to its historical numbers and its competitors. It seems undervalued based on a comparison to its chief competitors and historical multiples.

Apple

Google

Microsoft

Trailing P/FCF*

9.68

22.74

13.86

Trailing P/E

9.61

25.89

17.37

QOQ EPS

-17.95%

12.80%

19.51%

Dividend Yield

3.03%

N/A

2.73%

*Trailing P/FCF = Trailing price to free cash flow.

**Quarter-over-quarter earnings per share.

***All data sourced from Reuters.

T = Technicals Are Weak

Apple is currently trading at around $401, below both its 50-day moving average of $440.20 and its 200-day moving average of $458.38. From the chart below, we can clearly see that Apple has been on a downtrend during the past six months. Investors should wait until the stock’s 50-day moving average shows some sort of upward momentum before deciding to go long on Apple.

Conclusion

Apple remains a fundamentally sound company with high-quality products. Despite its poor stock price performance, CEO Tim Cook has emerged from Steve Jobs’s shadow while articulating a strong vision for the company. Cook and Jony Ive, Apple’s chief designer, need to release a blockbuster product this fall in order to change investor sentiment. While there is short-term downside based on Apple’s shrinking average selling price and gross margins, there is tremendous medium-term upside, as Apple is due for at least one big product release this autumn.

In the short-term, investors should pay close attention to Apple’s plans to increase its global marketing presence and the introduction of a lower-priced iPhone later this year. Apple and Samsung share a duopoly in the smartphone market, and establishing a strong presence in emerging markets is paramount to Apple’s future financial success. Apple may see its profit margins take a hit, but the increased volume from selling lower-priced iPhones should more than make up for lower margins.

Domestically, the Fed’s decision on whether to continue or halt its quantitative easing program exposes Apple to some downside risk. If the Fed ends its bond-buying program too abruptly, it’s likely that consumer sentiment will plummet, with consumers opting for lower-cost alternatives to Apple products, thus reducing company profits further.

For investors who were reluctant to buy Apple last year because of its high price, now may be a great opportunity to establish a long position in the stock; many believe that Apple’s stock will hit a fresh 52-week low at around $360 before the company’s fourth quarter begins. Apple definitely looks like a second-half story. For now, investors should wait until the price falls a bit before buying and see how Apple’s third quarter ends up. So for now, Apple is a WAIT AND SEE.